….the key ideas.

Webnote 122 1

1 formula 4 elasticities - see webnote 122

PRICE ELASTICITY OF DEMAND: THE SIMPLE or POINT FORMULA % CHANGE IN QUANTITY DEMANDED % CHANGE IN PRICE ’reverse of slope’ or quantity (x) / price (y)

Webnote 123 2

ped-demand yed-income demand xed-cross demand pes-supply

�  4 alternative elasticities �  Some key points to note for your answerability

Webnote 123 3

What is ped about?

D

Diagram 1: Price elasticity of demand and total revenue

0 Q

P

q1

A

C p1

p2

q2

D

Webnote 122 4

What is ped about?

Webnote 122 5

�  D

5%

2%%

PED: result is -2/+5 = -0.4 Ped is inelastic. What will happen to TR?

P e D Price elasticity allows us to classify goods whereby the results of the elasticity calculation determine one of the following: 1.  TR is key focus. (TR = P*Q) 2.  NORMAL (ped, negative) 3.  GIFFEN (ped, positive) 4.  ELASTIC (e >1) 5.  INELASTIC (e < 1) 6.  UNITARY ELASTIC ( e= 1) 7.  Elasticity is a key issue for LDC’s. 8.  commodities / primary goods face price

inelastic demand. This is critical for LDC’s Webnote 123 6

�  Government can use Ped to guide indirect

tax policy. How much tax the government want to place on goods + services depending on objectives e.g. demerit goods (cigarettes) can take higher rates of tax due to inelasticity but other goods will have a lower rate because the indirect tax will make the market smaller and government may not want to risk damaging the market

�  Firms can use ped to plan pricing and therefore total revenue i.e. total revenue planning will allow the firm to forecast and estimate profit levels and ‘what to produce? And how to produce?

Webnote 123 7

ped Evaluate PED (useful for long essay)

v  Ped (and all elasticities) often changse at different points on the curve

Yed-income elasticity of demand

INCOME ELASTICITY OF DEMAND: % CHANGE IN QUANTITY DEMANDED (Qd) % CHANGE IN INCOME (Y)

Webnote 123 8

Yed-income elasticity of demand INCOME ELASTICITY OF DEMAND:

% CHANGE IN QUANTITY DEMANDED (Qd) % CHANGE IN INCOME (Y)

Webnote 123 9

IBQ for 99 May 2014 syllabus 1.2 SL

2(a) Distinguish between the concepts of income elasticity of demand (YED) and cross price elasticity of demand (XED). (10 marks) 2b) To what extent might the concepts of income elasticity of demand (YED) and cross price elasticity of demand (XED) be of significance to business organizations? (15 marks) May 2013 syllabus 1.2 SL 2(a) Explain the factors which might influence the cross price elasticity of demand between different products. 2 (b) Examine the importance of income elasticity of demand for the producers of primary products, manufactured goods and services. M13/3/ECONO/SP1/ENG/TZ1/XX

Engel Curve Effect

Webnote 123 10

0

http://www.economicsdiscussion.net/cardinal-utility-analysis/notes-on-income-consumption-curve-and-engel-curve-with-curve-diagram/1040

Engel Curve: situation where the proportion (%) of income spent on food (necessities)decreases as income increases

Engel Curve Effect on demand for luxury goods

Webnote 123 11

Weekly income

Quantity demanded of luxury goods

0 http://www.economicsdiscussion.net/cardinal-utility-analysis/notes-on-income-consumption-curve-and-engel-curve-with-curve-diagram/1040

Engel curve

Engel Curve: situation where the proportion (%) of income spent on food (necessities)decreases as income increases

YED + economic growth: firms like to know how the economy is likely to perform. This assists their planning for output

Income elasticity

Webnote 123 12

Diagram 2: Elasticity-Business + Income using a Business Cycle diagram

0 Time

National Income/Growth

Boom Recession

Depression

Nat

iona

l Inc

ome

/ Gro

wth

Time

For a detailed business cycle diagram analysis see syllabus 2.1 webnote 214

Note: as income rises business and consumer confidence rises. See https://www.cesifo-group.de/. Economy is likely to grow further.

YED: who is interested?

Webnote 123 13

Why are business and government interested is a BIG question for YED

Firms: 1.  does the firm produce

inferior ( more demand in a recession as demand and spending falls) OR superior goods ( more demand in a boom when demand and spending rises)?

2.  Firms therefore need to make a business plan as to what they will produce and what quantities of FOP will be required

Government: 1.  is interested in order to estimate how

better to manage the economy to have more growth and more jobs. Too little spending is bad (unemployment) but too much spending can also be bad (inflation).

2.  When government can estimate YED they can also estimate how much tax revenue they will collect and therefore how much they have for merti and public goods

Some key points

yed

Webnote 123 14

Y e D 1.  INFERIOR (yed, negative) 2.  See yed 1+2 in slide 3 3.  ELASTIC (e >1) 4.  INELASTIC (e < 1) 5.  UNITARY ELASTIC (e = 1) 6.  YED elasticity is a key issue for LDC’s commodities /

primary goods tend to be income inelastic. Necessities such as food products. This is critical for LDC’s (yed 3 in diagram 3, slide 3). Increases in incomes in DC’s not a great benefit for LDC’s selling low priced food items.

7.  Manufactured+luxury goods tend to be income elastic (yed 4). DC’s benefit by selling luxuries. More profits!

8.  See question 2b on slide 2 above.

�  Government can use yed to manage the

macroeconomy e.g. how will rises in income affect output in the economy?

�  Firms can use yed to plan output for the long run i.e. does firm need more factors of production in order meet increased demand from customers as incomes rise?

Webnote 123 15

yed Evaluate YED (useful for long essay)

v  Yed is difficult to calculate accurately into and results may change over time so planning for the long run will be complicated

XED CROSS ELASTICITY OF DEMAND: % CHANGE IN QUANTITY DEMANDED OF GOOD A % CHANGE IN PRICE GOOD

B see exam question below (May 2004 HL2)

May 2014 syllabus 1.2 SL 2(a) Distinguish between the concepts of income elasticity of demand (YED) and cross price elasticity of demand (XED). (10 marks) 2b) To what extent might the concepts of income elasticity of demand (YED) and cross price elasticity of demand (XED) be of significance to business organizations? (15 marks) May 2013 syllabus 1.2 HL 2(a) Explain the factors which might influence the cross price elasticity of demand between different products. Webnote 123 16

XED CROSS ELASTICITY OF DEMAND: % CHANGE IN QUANTITY DEMANDED OF GOOD A % CHANGE IN PRICE GOOD

B see exam question below (May 2004 HL2)

Webnote 123 17

+ = substitute goods

- = complementary goods

XED: Coca Cola or Pepsi?

Webnote 123 18

Xed 1

Xed 2

Price Of Pepsi

Quantity demanded of Coca Cola

0

Elastic or inelastic? Xed 2 is inelastic Customers make small change in reaction to price changes of competitor (Pepsi) % change in Qd of CC < %change in P of Pepsi Xed 1 is elastic Customers respond to price changes strongly by buying Coca Cola % change in Qd of CC > % change in P of Pepsi

Xed 1 or Xed 2 best represents the competition between Coca Cola and Pepsi?

You can show XED on 1 diagram.

XED: Coca Cola or Pepsi?

Webnote 123 19

Demand

Price of Coca Cola

Price Of Pepsi

Quantity demanded of Coca Cola

0

OR You can show XED on 2 diagrams.

0

D1

D2

Quantity demanded of Pepsi

�  Xed allows firms to observe how

changes in prices of competitor products will affect theie firm or how their demand will be affected by changes in the prices of complementary products

Webnote 123 20

xed Evaluate xED (useful for long essay)

v  Xed is difficult to calculate accurately as price information may change regularly in a competitive market e.g. fresh fish and meat prices

PES PRICE ELASTICITY OF SUPPLY: THE SIMPLE or POINT FORMULA % CHANGE IN QUANTITY SUPPLIED % CHANGE IN PRICE Note: Q/X of line as in diagram 1 below has a key bearing on elasticity

IBQ for 99 Explain why the PES for primary commodities is relatively low and the PES for manufactured goods is relatively high. Syllabus: item 25

Webnote 123 21

Webnote 123 22

P e S

Shows ability of firms to adjust to changes in price. Firms that have elastic price elasticity of supply can benefit from sudden changes in price. 1. ELASTIC (e >1) 2. INELASTIC (e < 1) 3. UNITARY ELASTIC

( e= 1)

Elastic or inelastic?

Webnote 123 23

S1 S2

price

quantity 0

s1: pes = elastic, > 1 s2: pes - inelastic, <1

Elastic or inelastic S2 is inelastic Firm has little ability to react to price changes % change in Qs < %change in P S1 is elastic Firm has ability to respond to price changes % change in Qs > %change in P

PES – which firm would you prefer to own S1 or S2?

PES Alternative shapes for PES

Webnote 123 24

S1

S2

S3

price

quantity 0

Perfectly elastic

Perfectly inelastic

Pes = zero

s1: pes = zero S2: pes >1 S3: pes = infinity

Alternative results for PES

PES Alternative shapes for PES

Factors which influence the PES: e.g. if goods are highly perishable e.g. fresh fish then the Pes is likely to be like S 3 in diagram 2. Each of the points below can be applied to the diagram below.

1.  Perishability- s1 2.  Availability of substitutes: more

substitutes then PES higher in value (s2)

3.  Time factor: All supply is elastic over time. Time is of key importance for PES (s2) (s3)

4.  Availibility of stocks: more stock supply is more elastic (s2)

5.  Storage costs: lower costs of storage more elastic (s2)

6.  Input / FoP costs: higher costs less elastic

7.  Specialised labour: shortages can affect ability to increase output (s1)

8.  Spare Capacity: Farmer with unused field. No output increase in SR (s1) but Factory with unused machine can produce more manufactured goods ( s2)

Webnote 123 25

S1

S2

S3

price

quantity 0

Perfectly elastic

Perfectly inelastic

Pes = zero

�  Firms can use Pes to plan output in the

short run i.e. does firm need more factors of production in order meet increased demand from customers as prices rise?

Webnote 123 26

pes Evaluate pes (useful for long essay)

v  Pes is difficult to calculate accurately as information and results may change over time so planning for the long run will be complicated e.g. new technology may have a significant impact on how the firm produces and the level of productivity in the firm

Summary 1

Webnote 123 27

Summary 2:

28 Webnote 123

PeD > 1 < 1 = 1 TR YeD “i to I” > 1 < 1 = 1 + or - (inf) XeD > 1 < 1 = 1 +(sub) or - (com) PeS > 1 < 1 = 1 + or - (time)

4 Elasticities: 4 stories

Note: for pes and ped be sure you know the factors that make each in(elastic) See webnote 122 for ped and for pes see slide 18 above!

Webnote 123 29

4 elasticities = 4 stories

Inferior

PED

Total Revenue

PES XED

YED

Complement or Substitute

Resource allocation